For a few seconds, you don't know what it is you're looking at. There's something wrong with the photograph. Two people are involved in a sex act. Both are naked. One is three times the size of the other. The small one has pigtails. She looks a bit like your neighbour's daughter.

Every day thousands of paedophilic photographs showing adults abusing small children are posted on the Internet. The photos can be found in online newsgroups, the 90,000 or so 'discussion' forums that form the underbelly of the Internet and allow cyber-surfers to debate everything from American football to favourite television soaps.

Often snaps are posted in reply to a plea from a user seeking a particular kind of photograph. Those using the newsgroups to swap snaps talk to each other all the time. There is a sophisticated network. Frequenters of the newsgroups adopt handles such as Jet Boy and Captain Ecchi.

'A lot of the people who take this stuff seriously are serial collectors. That's why when we go into their computers we find they've got something like 6,000 stored images,' said Chief Superintendent Martin Jauch of the Metropolitan Police Force's Clubs and Vice Unit. But in addition to the older photographs, dating back to the 1970s, fresh ones appear daily. Many show children from the Far East and Third World. A large number are from the former Soviet Union. Only around 4 per cent originate from within the UK.

'It's like trafficking women. The same economics and geography applies,' Jauch said. Often a photograph will come with an abstruse website address that reveals a gallery of hardcore images, all of which can be viewed in return for a credit-card payment.

To enter the newsgroups a user needs to be signed up with an Internet Service Provider. Virtually all ISPs - including the big names such as BT, Freeserve and Virgin - ban what they believe are some of the more explicit newsgroups. There is one ISP, based in the US, that makes a great play of offering all the 90,000 newsgroups and guaranteeing subscribers anonymity. In Britain, the range of newsgroups is more restricted, a fact that angers many who believe that cyberspace should be unregulated.

Demon, one of the UK's largest ISPs with nearly 300,000 customers and owned by telecoms giant Scottish Telecom, now called Thus, is a strong supporter of an uncensored Internet and carries a number of the newsgroups banned by most rivals. The newsgroups are often explicitly named: several are described as pre-teens erotica. Others hide behind impenetrable acronyms. Sources in the Internet world suggest that there are up to 40 newsgroups carried by Demon that promote paedophile material.

Newsgroups are stored on an ISP's own news server - a computer database that records all the posted messages. If it were proved that Demon was aware paedophile material had been placed on its server and had failed to remove it, the ISP would be breaking the law. Demon says it acts quickly to remove paedophilic material when it is drawn to its attention.

Yesterday The Observer found scores of paedophilic material in several newsgroups carried by Demon. Some showed young teenage girls and boys; others were of young children performing sex acts on adults. It is illegal to download such material, but this newspaper, which has now destroyed the images, believes it was acting in the public interest.

Four years ago the Government became so worried about the way the Internet was becoming a playground for paedophiles that it threatened sweeping regulatory measures. Ministers became alarmed after the Metropolitan Police issued a list of 133 newsgroups which it believed contained material of a criminal nature.

In response, the ISPs, terrified that their autonomy was about to be curtailed, formed what was to become the Internet Watch Foundation, a self-regulatory body made up of the big players in the Internet. Demon was a driving force behind the creation of the IWF. One of its Internet experts, Clive Feather, be-came its first chairman. The idea was that the IWF would alert the ISPs to the presence of paedophilic material on their servers and would pass on complaints from the public. If an ISP refused to remove the material, the IWF would then alert the police.

But it is clear that something failed to spark at the IWF and in 1998 the Government called in advisers from accountants KPMG and law firm Denton Hall to suggest how the organisation could be strengthened. Relaunched last month, the new look IWF is endorsed by the Government and, in particular, the Department of Trade and Industry, which played a 'facilitating role in its creation', according to a DTI spokesman.

At the time of its launch, Patricia Hewitt, Minister for E-Commerce, said: 'The Internet Watch Foundation plays a vital role in combating criminal material on the Net.' To offset accusations of bias in favour of the ISPs, a new independent chairman was appointed. Roger Darlington, head of research at the Communication Workers Union, heads an enlarged 13-strong board. However, Demon retains two places on the board. Feather chairs the IWF's funding body. Demon contributes around £30,000 a year to the IWF's £225,000 running costs.

Critics have suggested that the fact that ISPs, notably Demon, continue to sit on the industry's own regulatory board represents a conflict of interest. But the Government is loath to scrap the IWF, believing a self-regulatory system is the best solution to a complex problem. The Metropolitan Police also believe that working with the ISPs, rather than trying to force some strong-arm solution, is the way forward.

'We have always taken the view that the co-operation approach was the best one. My disappointment is that the industry in general has not felt it possible to agree a consistent policy,' Jauch said.

Demon has in the past argued that deleting selected newsgroups was counter-productive. The IWF's Darlington said: 'There's a debate in the industry as to whether that [banning certain newsgroups] would shuffle the problem elsewhere.'

Certainly this policy of 'containment', as it is known in the industry, appears to have reaped dividends. The IWF, by monitoring some of the most notorious newsgroups, was able to alert the police to a prolific distributor of paedophile material. Leslie Bollingbroke, 42, who used the Internet pseudonym 'Sam', was recently jailed for four years for posting images of children.

However, the containment argument gets short shrift from other quarters.

'There is no evidence to support this argument, and much to suggest that it is misguided. Most British ISPs have removed paedophile groups without any increase in the amount of illegal content posted to other groups,' one expert said.

Critics of the self-regulation model also point out a paradox at its heart. The IWF often has to rely on tip-offs from the public. But few members of the public will admit to having downloaded paedophiliac material because this is a criminal offence. Recently the IWF's remit was expanded to examine racist publications in newsgroups - a move critics fear may dilute its ability to monitor paedophiliac postings even further.

The police, too, have only limited resources. 'Our Internet unit is very small. We can't monitor what goes on right across the Internet,' said Jauch.

Demon declined to comment on why it was practically the only ISP to continue to carry newsgroups that have been shown habitually to carry paedophilic material. In a written response to The Observer 's questions it stated: 'Newsgroups have long been established as being one of the most valuable of these services, and at their best serve to unite interested parties across the globe to share knowledge and information.'

Critics say paedophiles will merely end up subscribing to foreign ISPs if all of their UK rivals ban selected newsgroups, so a blanket prohibition is futile. However Jauch said: 'That's the same as a club owner saying, "Lots of people take drugs so therefore it's OK if I allow drugs in my club".'

One observer said: 'It's an interesting balance between the protection of children and civil liberties. Although it's not that difficult to work out which side most people fall down on.'